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Could Mortgage Rates Go Even Lower?

At least when it comes to low rates, mortgage borrowers have
never had it so good. But with millions of homeowners already
having
refinanced their loans
to save hundreds on their monthly mortgage payments, it seems
almost inconceivable that rates could go still
lower
in the future -- especially as the economy apparently starts to
pick up steam.

But that's exactly what bond guru
Bill Gross
foresees happening in the coming months. With help from the
Federal Reserve, mortgages could get even cheaper, providing what
appears to be increasingly important support to the slumping
housing market going forward.

Later in this article, I'll talk about the ramifications of
this move for homeowners and investors looking for ways to profit
from it. But first, let's look more closely at the Fed's strategy
thus far.

The move could come as part of the Federal Reserve's ongoing
interventions in the bond market. In an interview with Bloomberg,
Gross suggested that as the current "Operation Twist" bond-buying
program comes to an end at mid-year, the Fed could change the
program by targeting mortgage-backed securities rather than
Treasury bonds.

So far, the focus of Operation Twist has been to make sure
that the Fed keeps a handle not only on the short-term rates it
controls by way of its Fed Funds rate, but also on the longer end
of the yield curve. Without both elements, only short-term
borrowers would get the benefits of lower rates; mortgage
borrowers and others who need to get long-term capital via the
debt market could be left facing much higher financing costs as
improving economic conditions led to natural expectations of
rising rates.

The Fed's moves so far have kept long rates lower. But a new
emphasis on mortgage securities rather than regular Treasuries
could boost some investments.

First off, any change in which securities the Fed uses for its
rate-controlling operations would have a direct impact on the
markets it targets. Treasury bonds have traded at historically
low rates in recent years as the Fed's numerous quantitative
easing programs have pushed up demand for Treasuries. Because
Treasury rates are often used as benchmarks for pricing other
types of debt, the move has had a collateral impact on financing
costs for businesses, municipalities, and a wide variety of other
borrowers. If the Fed starts concentrating on mortgage loans,
then spreads between mortgage rates and Treasury rates could fall
substantially -- either by having Treasury rates rise (as they
have recently) or by forcing mortgage rates to drop.

The next obvious winners would be investors in mortgage bonds.
One place to find huge mortgage-bond portfolios is inside
mortgage REITs
Annaly Capital
(
NLY
) and
ARMOUR Residential
(
ARR
) . It's likely that the Fed would concentrate on mortgages
backed by
Fannie Mae
or
Freddie Mac
, thereby leaving
Chimera Investment
(
CIM
) and other investors in non-agency mortgage debt with a much
smaller impact from the program.

Finally, banks that profit from mortgage activity could once
again see another one-time boost to their profits. Just as
Wells Fargo
(
WFC
) and
Bank of America
(
BAC
) both reaped big transaction-based profits from the waves of
mortgage activity during the housing boom, so, too, would they
stand to benefit from homeowners taking advantage of one more
chance to refinance at super-low rates. Of course, the long-term
impact could be to pull future activity forward, leaving banks
with weaker profits down the line. But with the focus on current
results among financials, that's probably a trade-off that most
banks would be willing to make right now.

It's too early to tell exactly what the Fed will do with
rates. But one thing is clear: The economy isn't out of the woods
just yet, and a number of options for stimulating the economy are
still on the table. If Gross is right and the Fed moves forward
with another jolt to the mortgage market, homeowners might get
another chance to free up a little extra cash every month.

No matter what happens to rates and your mortgage, you still
have to invest in order to build the financial cushion you need.
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Fool's latest special report on retirement, where you'll find
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